Retail Space

Economist's Commentary: Retail Space

By George Ratiu, Research Economist

With a 70-percent contribution to gross domestic product (GDP), consumer spending is an important measure of economic activity. Since 2007, consumer spending has been on a volatile ride, driven by the downturn in the economy, the large number of job losses and declining home values.

In the fourth quarter 2009, which included the holiday shopping season, consumers maintained a cautious approach to spending. While modest, spending was a positive 1.7 percent. Consumers increased their spending on both goods (up 2.8%) and services (up 1.2%). In a sign that consumers are focused on essential items, spending on durable goods was only slightly higher in the fourth quarter, by 0.2 percent. While consumers increased their spending on furnishings, household equipment, and recreational goods, they cut back on motor vehicles. Meanwhile, consumers increased their spending on necessities, such as food and beverages, as well as clothing and shoes.

Retail sales in December cemented the soft performance of the fourth quarter 2009, declining 0.1 percent. The start of 2010 posted a slight improvement in the pace of spending. Retail sales in January increased 0.5 percent, driven by activity at general merchandise, computer and electronics, as well as on-line stores. On a positive note, businesses have been aggressively slashing inventories over the past year and a half, in response to lower demand. Based on Census Bureau data, the level of retail inventories has been moving sideways, pointing to a likely bottom.

However, while expectations for continued economic growth solidify, the stubborn level of unemployment dampens the outlook for 2010. For a sustainable rise in consumer spending, the economy needs a matching steady rise in employment. So far, that growth has proven elusive. Except for a solitary 0.6% rise in November 2009, payroll employment has been declining for two years. Over this period, 8.4 million jobs have been cut, leaving many job seekers discouraged at prospects of a recovery. Mirroring this trend, initial jobless claims increased by 22,000 last week to almost half a million, while the number of people receiving unemployment benefits reached 4.6 million last week. To provide perspective on this, the economy needs the number of initial jobless claims to be around 350,000-400,000 to result in net job creation.

Based on the employment picture, consumers are showing signs of weariness. The University of Michigan index of consumer sentiment has been providing a volatile picture over the past year. While consumer sentiment about current economic conditions has been moving in an upward trend, the gain has been tempered by consumer expectation, which have been considerably more subdued. In February 2010, the index declined to 73.6 from 74.4 in January.

Adding to the uncertainty of the economic environment is the shrinking level of consumer credit.

Based on the Federal Reserve’s latest report on consumer credit, monthly data registered a 0.9 percent decline in the annual rate of consumer credit in December 2009. The contraction comes on the heels of a 10.1 percent drop in November 2009, and marks 14 consecutive months of decline in available credit. Since July 2008, consumer credit has shrunk by $125 billion.

Notably, revolving credit, such as credit cards, dropped 17.1 percent in November and 11.1 percent during December 2009. Over the past year and a half, non-revolving credit—such as credit for automobiles, trailers, durable goods, vacations, etc.— has been mostly on a level path. Given the economic uncertainties and shrinking financing, consumers are likely to maintain a muted pace of spending.

In response to these factors, demand for retail space is projected to remain weak for the better part of 2010, with a likely improvement in the last quarter of the year. Net absorption in 2009 totaled a negative 18.3 million square feet. For the first quarter, net absorption is expected to decline 2.0 million square feet. It is worth noting that while still negative, the decline in demand for retail space has been steadily improving through the last four quarters.

The improvements in net absorption have been moderated, however, by a steady flow of new retail properties. Completions of new retail space continued on a fairly consistent pace throughout 2009. The first half of the year witnessed about 6.0 million square feet of new retail space, followed by another 6.0 million square feet in the latter half. Based on projects in the pipeline, the first quarter 2010 is expected to add another 1.3 million square feet.

While the inflow of retail space will taper off in 2010, given the level of completions, availability rates are poised to continue their upward momentum. Retail vacancy reached 12.4 percent in the fourth quarter 2009, and is expected to rise to 12.6 percent in the first quarter of this year. Meanwhile, rent for retail spaces declined 4.0 percent in 2009. While the drop in rents has ameliorated towards the end of 2009, it is projected to remain negative—the expectation for 2010 is for an additional 2.4 percent decline.

On a regional basis, coastal markets continue to feel the effects of stronger employment. California markets continue to dominate the top ten markets with the lowest availability rates. For the first quarter, San Francisco is expected to post the lowest vacancy rate, at 6.6 percent, followed by Honolulu, Orange County and San Jose. With regional economies still affected by employment losses, the Midwest is finding higher vacancies. The markets with availability rates higher than the national average are Indianapolis (19.0%), Detroit (18.1%), Columbus (17.9%), Cincinnati (17.7%), and Cleveland (16.7%).

Lowest Retail Vacancy Rates

2010.Q1 Estimates

San Francisco, CA 6.6%
Honolulu, HI 7.5%
Orange County, CA 7.6%
San Jose, CA 7.8%
Long Island, NY 8.3%
Miami, FL 8.5%
Los Angeles, CA 8.5%
San Diego, CA 9.6%
Ventura, CA 9.9%
Oakland, CA 10.0%
National Average* 12.6%

Source: NAR / CBRE-EA
*Not all markets are represented


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